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An Introduction to Commercial Loan Documents

Mar 6, 2008
The financial stakes are much higher when you're involved in commercial investments rather than residential deals. In the case of commercial investments, the rewards are greater, but the risk can also be significantly higher. Therefore, it will pay you to understand completely the terms and wording of commercial loan documents before you ever sign them. In this article, I'll provide you with the necessary knowledge of the basic loan forms and language. But, first, you should understand the two kinds of lenders you'll be dealing with in this market.

Most commercial lenders are represented by mortgage bankers. These bankers work on behalf of a fixed number of lenders and often have long-standing relationships with them.

The second kind are called "mortgage brokers." They're middlemen or "shoppers;" that is, they shop your loan application around to lenders and operate on an individual deal basis.

Go with mortgage bankers if at all possible. They're more likely to be well-connected within the financial community so they'll be able to steer you to the right person for your project. Also, they're usually cheaper than brokers. When using the services of the broker, you have to pay two fees-one for the broker in addition to the lender's fee.

Now, let's look at the basic and standard commercial loan documents and their wording.

The Promissory Note A promissory note is a written promise to repay the loan. It's spelled out in very specific terms. These terms vary with the particular note, but they generally include the following items: * Date * Borrower and lender names * Address of lender * The principal sum * Interest rate * Term * Place of payment * Terms of repayment * Terms of late payment charges * Promise to pay * Acceleration and pre-payment stipulations * Deed of trust or mortgage attached * Attorney's fees and other boilerplate items * Signatures and date

Loan Priority Priority simply stipulates who gets paid first. The lender has "first position." This is a protection for the lender and means that the lender's rights are subject only to the payment of real estate taxes. This means the lender has the ability to pay the taxes to protect his or her position.

There are also "junior" positions-second, third, and so forth. If a lender is in second position, then they have to bring the loan up to current status or pay it off to eliminate any default on that loan. Priority is determined by the date of recordation.

Securing of the Loan Notes must be secured, and this is done by recording of the mortgage or deed of trust. They're liens against the property and are security instruments. Recording of a mortgage or deed of trust has two purposes. First, it establishes the priority I mentioned earlier. Second, it makes public the fact that the lien exists. This allows prospective lenders to establish the priority of the lien in regard to any proposed financing.

Whether a mortgage or deed of trust is involved depends on the area of the country in which you live. Eastern states tend to use the traditional mortgage format while Western states tend to use the deed of trust. Both are essentially the same; the main differences lie in who draws up these documents. In mortgage states, an attorney is usually required to prepare the document. In deed of trust states, it can be drawn up by a title company.

Both of these non-negotiable security instruments are universal to all real estate property borrowing and are often standardized. They include such information as: * The account number * Borrower's name and mailing address * Beneficiary's name and mailing address * Trustee's name and address * The date * Property description (location, town, county, state, address, etc.) * Note amount * Purpose of the document ("recitals") * Terms and conditions * Mutual agreements (rights of assignment, damages, trespass, personal guarantees, etc.) * Additional security (if required) * Default provisions and remedies * Recording authority * Successors in interest * Rights of assignment * Signatures and date

Special Provisions Special provisions may be added to the general terms of the mortgage or deed of trust. Here are two examples:

Cross collateralization Assume a borrower has more than one property and offers them as collateral for the loan. When this occurs, the mortgage or deed of trust is recorded against all these properties. Therefore, when any of these collateralized properties are sold, the proceeds go to the lender before any payment is made to the borrower.

Personal guarantee A personal guarantee can occur when the borrower doesn't have sufficient collateral to secure the note in full. He or she is required to guarantee to pay the difference of the short fall. My advice is to avoid personal guarantees at all costs since the lender can require you to pay the note in full! You want to avoid any situation where you may end up without money and are still stuck with the property.

As I indicated earlier, this article is intended only as a basic introduction to commercial loan documents. Before engaging in any deals in this market, I recommend you study the documents in detail so you have full understanding of the terms and conditions you'll have to abide with once you put your name on the dotted line.

Key Concept: Understand completely the terms and wording of commercial loan documents before ever signing them.
About the Author
Jack Sternberg is the creator of the renowned "Buyers First Program". As the "gurus' guru", he is well known by the professional creative real estate community as "Obi-Won Kenobi". Having been a full time investor since 1977, Mr. Sternberg has been "at" the closing table more than 1,500 times. Mr. Sternberg has the depth of experience that lend value to his associations. Contact Mr. Sternberg at www.askjacksternberg.com
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